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THE ONGOING MORTGAGE-DEFAULT TORNADO HIT FANNIE MAE with ferocity last week, when the mortgage giant reported a first-quarter loss of $2.2 billion, its third quarterly loss in a row.

Rising credit costs -- industry lingo for foreclosure costs and reserves against future loan charge-offs -- was the primary culprit. Nor did management sound many cheery notes in the news release or conference call afterwards. They boosted the expected range of home price declines for 2008, to 7% to 9% from 5% to 7%. Therefore mortgage defaults will be even higher next year.

The company also announced a 30% cut in the quarterly dividend to marshal capital and a plan to raise $6 billion in new common and preferred equity (some $4.5 billion in new issues were priced later in the week).

Our idea that Fannie might need a bailout has been getting fresh attention in Washington.

We had sounded a strikingly bearish note on Fannie in a cover story earlier this year ("Is Fannie Mae Toast?" March 10). We pointed out that Fannie, by virtue of its location in the heart of the home- mortgage-market collapse, was likely to face many quarters of crippling losses that would all but deplete its capital.

We surmised that the U.S. government might be forced to nationalize the company in order to fulfill its implicit guarantee of Fannie's huge corporate and guaranteed debt obligations. The possibility of a bailout like that has recently been getting more attention from regulators and lawmakers, as the New York Times reported in a front-page story last week.

The latest earnings report did nothing to change our gloomy view. For example, in the first quarter Fannie was forced to torch its "fair value" net worth by $23.6 billion to a paltry $12.2 billion. After subtracting $14.3 billion in net worth attributable to Fannie's preferred stock, that left common shareholders with negative equity of about $2 billion. That's surely not much protection against future losses on Fannie's $3-trillion credit book.

That net-worth hit occurred in an area that our story highlighted. By our reckoning, Fannie had badly overestimated the net value of its business of guaranteeing mortgage securities, in light of the heavy losses showing up there. Its accountants apparently agreed, to the tune of the $26 billion reduction in the value of the business that Fannie took in the first quarter.

In the March-quarter numbers, Fannie also mentioned some $9.1 billion in unrealized losses, some $8 billion of which it failed to run through its income statement on the grounds that they were merely temporary. These losses come from subprime and Alt-A (a notch above subprime) securities that are likely to prove anything but temporary.

FINALLY, SOME FUNKY ASSETS ON FANNIE'S balance sheet that we'd discussed in our original story have only grown since. To wit, Fannie in its latest numbers reported that deferred-tax assets had jumped from $13 billion to $17.8 billion in the quarter. Yet as losses continue, these tax offsets to future income will have to be written down sharply, thus crushing both Fannie's future earnings and net worth.

Bulls on Fannie look to improved profits the company is realizing on newly booked business in both its guarantee business and investment portfolio. Likewise they are counting on government regulators to be lenient with the company because of its importance in providing liquidity to the ailing home-mortgage market. After all, Fannie was able to "grow" its way out of near oblivion after the savings and loan debacle in the 1980s.

Such a turnaround now would be far more difficult, given the virulence of the current credit cycle and housing-price crisis. As one report last week noted acidly, Fannie has become the lifeguard that can't swim.

-- Jonathan R. Laing

Constellation: Stars Are Aligned

INVESTORS IN CONSTELLATION BRANDS HAVE HAD GOOD REASON to try to drown their sorrows, given that the stock of the wine and liquor producer has fallen more than 20% this year to the high teens from 23, where it was when we last wrote about it ("Time to Raise a Glass," May 14, 2007).

Fourth-quarter results, released recently and showing a net loss of $832 million versus a year-earlier profit of $72 million, certainly weren't worth toasting. But appearances are deceiving.

Excluding one-time charges, the latest numbers weren't as bad as expected. The company, the world's largest publicly traded wine maker by volume, with brands including Robert Mondavi and Ravenswood, has completed a sweeping restructuring. It has shed a good many of its lower-priced wine brands, such as Almaden, Inglenook and Paul Masson, and moved the greater part of its inventory to higher-priced, higher-margin offerings. That should help it deal with the impact of the ongoing world wine glut.

Constellation, which has a relatively small secondary business importing Mexican beer and liquor like Svedka vodka and Skol gin, has boosted cash flow and is looking for 2008 earnings of $1.68 to $1.78 a share, ahead of the previous consensus estimate of $1.67. The Street has boosted its 2009 earnings target to $1.90. That gain, along with continued signs of improvement as the year progresses, could propel the stock back up to around 25 -- enough to warrant a small nightcap.

-- Jay Palmer

Thomson Reuters Marriage Should Work

THE NEW THOMSON REUTERS RECENTLY REPORTED SOLID RESULTS for its March quarter, and held its first investor Webcast since the companies closed their merger last month. Executives said, however, that Wall Street's downturn might slow revenue growth from the quarter's 12% rate to an average of 7% for 2008.

The Stamford, Conn.-based data vendor's forecast of more cost savings didn't lift the shares from the losing track they've been on since we praised the merger ("Numbers Cruncher," May 14, 2007). The New York- and Toronto-listed stock has slid about 10% in the past year, to US$37.40.

"We are not immune to the cycle," acknowledged Thomson Reuters CEO Tom Glocer, on the Webcast.

He promised to give the widely admired Bloomberg a run for its money with a new Reuters trading terminal, and said his company is enjoying strong demand for its currency and commodities products, not to mention healthy data usage from lawyers working on restructurings.

The new outfit's long-term prospects seem pretty good. Cash expenditures from the merger will drop after this year, while savings will keep growing. The company says that 2008 revenue should rise by 6% to 8% from 2007's $12.5 billion, and its operating-profit margin could rise from about 19% to 20%. Its stock-market value of $24 billion is a modest 15 times expected free cash flow. As Thomson Reuters extracts more than $1 billion in merger savings and increases revenue from its financial, legal and tax data, the shares still look promising.